What is it?
Out of the myriad of options strategies out there, long put strategy is probably the simplest of all. Unlike most strategies, long put involves just one step. Suppose you are bearish on a stock in the next few days. You buy a put option on that particular underlying, and you wait for the stock to go down. That’s it. You win if the stock goes down, and you lose if it goes up. The maximum loss you would incur in this strategy is the option premium you pay to the option writer, and possible profits would be unlimited. As long as the stock keeps going down, the trade will be in your favor. This strategy is best suited for beginners.
Now, you must be wondering, why not just short sell a particular underlying. Once you short sell your losses, that’s also unlimited if the trade goes against you. That’s the beauty of options. However, there are certain things you should keep in mind to make the most out of options trading as a whole. Premiums and Volatility are the deciding factors in the losses you would be incurring and the profits you would be making. Premiums are less further in out of the money, so you need to get into the trade as soon as possible to minimize the premium, and Volatility should be high to reap maximum profits from a trade.
I will explain the strategy with the help of an excel template provided by marketXLS and then show the possible scenarios with a graph’s help.
Trading with marketXLS
MarketXLS is an add-on to MS Excel, which helps a user procure real-time stock data and import it directly to excel. Apart from this, it also provides templates to manage and track options trades for different strategies. Here, I have used Microsoft(MSFT) options as an example. This trade is not taken in real, and it is just for explaining. As I am writing this article, the MSFT shares are trading at $239. Let’s assume that the trend will be bearish in the next couple of days. Therefore, we bought a put option at $230, which will expire on 5-Feb-2021. The net investment for one contract (100) shares, as you can see, is $37.
Profit, loss, breakeven
We have bought an out of the money contract (100 shares) of MSFT with a strike price of $230 at a premium of $2. Let’s have a look at the possible scenarios:
1. Let’s say my assumption was right, and the stock moved down, say to $225. The intrinsic profit would be {($230-$225) * 100} that is $500 and the net profit would be {$500- $2*100}
that is $300. The profits will keep increasing with the stock moving downward.
2. If the stock moves in the other direction or doesn’t move, the contract will be deemed worthless, and my net loss would be the premium that is $200. This is the maximum loss I am going to make in this trade.
The breakeven point would be $228. Below is a graph to help explain the scenarios mentioned above more clearly.
This is a plot between profits and the share price of MSFT. The profits are unlimited below $228 and the losses are limited at $200 which happens after the stock crosses the target price on the bullish side.
The bottom line
To end the article, long-put is a beginner level strategy. The capital required will vary with the profit expectations. But the foremost driving force in this strategy would be the Volatility of a particular underlying. The losses are limited which is why this is a better strategy than just short selling an underlying.
Disclaimer
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The author is not offering any professional advice of any kind. The reader should consult a professional financial advisor to determine their suitability for any strategies discussed herein.
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References
Learn more about long put here.
